Depreciating Leasehold Improvements - You Need a Masters Degree in Taxation to Figure it Out

You would think a simple thing like how to depreciate leasehold improvements would have a simple solution. Unfortunately, Congress has made it a very complex matter. There is currently no one, single method for depreciating leasehold improvements. And there is no one single number of years in which the life of leasehold improvements may be depreciated.

For example, depending on the facts and circumstances, leasehold improvements may be required to be depreciated under the straight line method, or eligible for 50% bonus depreciation, or eligible for 100% bonus depreciation or eligible to be expensed (called section 179 Depreciation Method). Further, a leasehold improvement may be required to be depreciated over 39 years, or 15 years or 1 year or a combination of years. 

Why? Why has such a simple matter as depreciating leasehold improvements become so complex? 2010 tax legislation is interfering with other pre-2010 tax legislation and making a mess of things. in 2010, alone, there were six major pieces of tax legislation, the last one being the Tax Relief, Unemployment Insurance Re-Authorization and Job Creation Act of 2010 (2010 Tax Relief Act) (P.L. 111-312), which was passed on December 17, 2010.

But have no fear. Tom Corley to the rescue. I will, as usual, turn the incredibly complex into the incredibly simple. So simple that even Forest Gump would be able to understand and explain it to someone. So here we go....

Options of how to depreciate leasehold improvements:
1.  Expense 100% of your leasehold improvements in one year - You may qualify for what the IRS calls section 179 expensing allowance on qualified leasehold improvements. In order to qualify you cannot simultaneously be the landlord and the tenant (called the "related party rule"), you must have a profit, your deduction is limited to your profit, your deduction cannot exceed $500,000 and the leasehold improvement must be any improvement to an interior part of a building that is nonresidential real property in the United States, if all the following requirements are met:
  • The improvement is made under or according to a lease;

  • That part of the building is to be occupied exclusively by the lessee;

  • The improvement is placed in service more than 3 years after the date the building was first placed in service by any person;

  • The improvement is section 1250 property (think "real estate property" as opposed to computers, furniture etc);

      A qualified leasehold improvement does not include any improvement for which the expenditure is attributable to any of the following:

  • The enlargement of the building;

  • Any elevator or escalator;

  • Any structural component benefiting a common area;

  • The internal structural framework of the building.

2.  Expense 100% of your leasehold improvements in one year - You may qualify for what the IRS calls 100% Bonus Depreciation. In order to qualify you cannot simultaneously be the landlord and the tenant (called the "related party rule"), the improvements must have been made after September 8, 2010 and before January 1, 2012 and the improvements were/are/will be "qualified leasehold improvement property" (see definition above);

3.  Expense 50% of your leasehold improvements in one year - You may qualify for what they call 50% Bonus Depreciation. In order to qualify you cannot simultaneously be the landlord and the tenant (called the "related party rule"), the improvements were made in 2010 and the improvements were  be "qualified leasehold improvement property" (see definition above);

4.  Straight line depreciation over a 15 year period for "qualified leasehold improvement property" (see definition above). In order to qualify you cannot simultaneously be the landlord and the tenant (called the "related party rule"), the improvements were made in 2009 or 2010 and the improvements were "qualified leasehold improvement property" (see definition above);

5.  Straight line depreciation over a 39 year period for normal leasehold improvement property that does not qualify under items 1 through 4 above. This default rule is required in instances where you are both the landlord and the tenant of the leased property. In these cases leasehold improvements can never be treated as qualified leasehold improvement property. To make things even simpler for you, always assume your leasehold improvement must be depreciated under the straight line method over 39 years unless it meets the definition of "qualified leasehold improvement property" in which case this 39 year general rule would not be required to apply.

I wish to thank the 22 year old Congressional staff members who write the tax code and regulations, the IRS for their incomprehensible explanations thereof and the tax court rulings for making the U.S. income tax system as complex as it is, thus affording me and many other CPAs the opportunity to make a living in a completely unnecessary field.

 

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  • 8/19/2011 12:49 PM Robert E. Glazebrook wrote:
    LOVED IT!!
    So very, very true.
    Congress passes laws having have no idea--no conception as to their meaning or their ramifications.
    Reply to this

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